Paper checks are the most widely used type of non-cash payments in the United States. The electronic check (eCheck) is an all-electronic enhancement to the paper check, based on existing check law. This white paper briefly compares paper and echecks, based on five categories: usage, cost, allowance for errors, risk management, and information richness.
Financial institutions have been trying for over twenty years to change their customers’ behavior from the paper check to electronic transactions, with limited success. As can be seen by the table below, paper checks continue to be popular, and their use continues to grow.
Growth in Volume
|All Credit Card|
Source: Bank for International Settlement 12/97 (except ACH). Volume in Millions
1Source NACHA, 2CHIPS + FedWire
Both payers and payees value checks for many reasons, including providing a low-cost, user-controlled, ubiquitous solution to both payments and receipts.
Electronic checks, while certainly not ubiquitous, capture the important characteristics and end-user benefits of paper checks in an all-electronic form. They provide a peer-to-peer solution for direct exchange, are usable against existing bank accounts, are based on existing business practices, don’t require an active third party, and ensure that control of the transaction and timing remains in the hands of the transacting parties.
In spite of their popularity and widespread use, there are few reliable studies on the actual cost of paper checks to businesses. Estimates for a life cycle cost range between $.75 through $3.00 per check. Typically the costs fall into three main categories: supplies, handling, and uncollected checks. Supply costs include check stock, envelopes, deposit slips, printer supplies, signature stamps or plates, and postage. Business handling costs include the personnel costs for a wide range of activities such as stuffing and opening envelopes, routing, reading, entering and re-entering payment information, filing, sorting, creating deposit slips, researching returned items, reconciling accounts, etc. Bank handling costs include encoding, filing, lookup, balancing, sorting, clearing, transportation, statement rendering, processing, research, exception handling, etc. Uncollected checks include items returned for insufficient funds, stop payments, and fraudulent items. While all these activities sound small, together they are estimated to amount to annual expenses over $40 billion. Losses alone due to fraud and uncollectable checks are estimated by the Tower Group to be $14.5 billion in 1995.
Electronic checks significantly reduce the ongoing operating costs and losses associated with check payments. They make use of the Internet for nearly ubiquitous communication, and eliminate most of the manual steps required by paper checks. eChecks also enable, as discussed below, payment information to flow directly between payer and payee with the check. The eCheck system substitutes a higher up front cost in customer identification and state of the art security to reduce the costs associated with fraudulent checks. Since the system is fully automated, and echecks are protected against forgery or alteration, echecks will significantly reduce fraud while remaining easy to reconcile due to payer assigned check numbers. Overall, when widely used, echecks will save payers and payees significant expenses.
Allowance for Errors
Paper checks are a very forgiving payment system. Many types of errors can occur — yet the checks still get processed, cleared, and settled. Dates and signatures can be accidentally omitted, amounts can be encoded improperly, or the checks can fail to be automatically read by the processing equipment. In any of these events, the checks are passed through the system, sometimes after repair with a new MICR encoding strip.
Electronic checks are not forgiving of errors, in fact, the eCheck system prevents erroneous payments altogether. Due to the use of strong digital signatures, and automated software edits, echecks must be completely and accurately created and digitally signed by an authorized party before they can be processed. This will dramatically reduce errors in the system, resulting in improved efficiency and lower operating costs for all involved.
Paper checks have provided us with a rich risk management environment by allowing a business to determine how much risk to accept on a per transaction basis. Businesses are free to establish transaction limits, require identification, use verification or guarantee services, ship before or after payment, etc. Banks have also developed sophisticated risk management practices for accounts and transactions to fight fraudulent transactions.
Electronic check builds upon these practices, and reinforces the control and distributed nature of risk prevention and management between all the parties involved in a transaction. The use of strong digital signatures and certificates greatly enhances the transacting parties ability to assess the validity of a transaction automatically, further reducing risk.
Paper checks themselves are not typically thought of as an information rich transaction. However, when compared to the information contained in most other electronic transactions, checks do carry more information. Unfortunately, this information is typically not in a form that can be captured and is therefore unusable. Beyond the information contained on the check itself, checks are most often presented with additional information, such as a remittance or invoice copy, that which must be manually entered into systems.
Electronic checks enhance the information value of paper checks substantially. First, the information carried on the eCheck itself is in a form that allows it to be usable. Second, by design, echecks can have unlimited information, in any format, attached and sent with the payment, much like a paper envelope can carry additional pages. Since this information is already in electronic form, it will be much easier to integrate into existing systems without manual re-entry, saving significant time and effort.